Ford, GM … Who’s Next?

Call the Fed, my favorite burger joint down the street is experiencing distress. Yeah, I’ll take a double with cheese, hold the TARP.

Not really sure how Detroit sees this all working out. Does the UAW and the “big” three (two public, one private, all three collapsing) still think that they are entitled to some sort of government intervention? The new White House Administration has made it clear that they are ready to help Detroit, and Speaker Pelosi can’t be any more vociferous of her own intent. So the question is, where, oh where, will it end?

The automakers priorities have been out of whack for quite some time now. You cannot help but laugh when you hear GM is the worlds leading purchaser of Viagra. The Detroit News reported in 2006 that GM spent $17 million dollars on the “little blue pill”. Admittedly, this is a relatively small portion of the more than $5.6 billion per year that GM spends on health care for their employees (more than $1500 per car in 2006), but the Viagra problem is a symptom of an overall cost management illness.

Thomas Friedman, Pulitzer Prize winning columnist and author (”The World is Flat“), has some interesting insights into the situation in yesterday’s New York Times. He first recounts the history of our esteemed car companies and their insatiable appetite for funds to, … uh… innovate:

Last September, I was in a hotel room watching CNBC early one morning. They were interviewing Bob Nardelli, the C.E.O. of Chrysler, and he was explaining why the auto industry, at that time, needed $25 billion in loan guarantees. It wasn’t a bailout, he said. It was a way to enable the car companies to retool for innovation. I could not help but shout back at the TV screen: “We have to subsidize Detroit so that it will innovate? What business were you people in other than innovation?” If we give you another $25 billion, will you also do accounting?

How could these companies be so bad for so long? Clearly the combination of a very un-innovative business culture, visionless management and overly generous labor contracts explains a lot of it. It led to a situation whereby General Motors could make money only by selling big, gas-guzzling S.U.V.’s and trucks. Therefore, instead of focusing on making money by innovating around fuel efficiency, productivity and design, G.M. threw way too much energy into lobbying and maneuvering to protect its gas guzzlers.

This included striking special deals with Congress that allowed the Detroit automakers to count the mileage of gas guzzlers as being less than they really were — provided they made some cars flex-fuel capable for ethanol. It included special offers of $1.99-a-gallon gasoline for a year to any customer who purchased a gas guzzler. And it included endless lobbying to block Congress from raising the miles-per-gallon requirements. The result was an industry that became brain dead.

Nothing typified this more than statements like those of Bob Lutz, G.M.’s vice chairman. He has been quoted as saying that hybrids like the Toyota Prius “make no economic sense.” And, in February, D Magazine of Dallas quoted him as saying that global warming “is a total crock of [expletive].”

These are the guys taxpayers are being asked to bail out.

– Thomas L. Friedman, NYT, Nov. 11, 2008

Friedman has a great knack for showing readers where we have been in very understandable terms and examples. He continues on to propose that Steve Jobs take a year off from Apple (AAPL) to come create the first “iCar”, which no doubt will run on MP3’s available only from the iTunes store. He really may be on to something there.

When looking at our ratings and valuations on companies like Ford and GM, it is really hard to reconcile the realities of Detroit with the opportunities to invest in depressed stocks. Well, maybe its not that hard. Right now, on a 13 week basis, GM and Ford are down around 70% each. The slide for GM has been an unrelenting death march from the high $80’s in 1999 to its present day. Ford’s decline from 1999 was a high price of $36 and change. Both companies have failed miserably to innovate or compete with their foreign counterparts.

Looking at the scatter plot chart, it is true that Ford and GM get a “Greatly Undervalued” rating right now from the Ockham methodology. We won’t drop coverage on them just because we think they are systemically broken (that’s Wall Street research). Instead, we basically sit here waiting to see if the government will again burn money by throwing it into the Detroit furnace. Please note, however, that when visiting our site, we slap an “ALERT” sticky note on both Ford and GM to highlight that our ratings can’t be viewed in a vacuum. While we advise doing a lot of homework on all companies, and think our clients need to look at multiple sources for their research, we also recognize that some truly deserving companies should be pointed out for the complete debacles they have become.

When looking at the major automotive manufacturers, we find Honda (HMC) and Toyota (TM) to be far more interesting (and they don’t get the yellow sticky note of death on our website.)

Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

We utilize this straightforward approach to value over 5500 securities, with key emphasis given to the study of individual securities' price-to-sales, price-to-cash earnings and other historical valuation ranges. Our long term value investing methodology is powered by the teachings of Ben Graham and it has proven to be very adept at identifying stock prices that are out of line with fundamental factors.

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1 Comment on Ford, GM … Who’s Next?

You're right, but you neglected to point out that the Japanese car industry was ushered into the US market by Congress, which decided to give them access on the cheap to existing car dealerships which had been developed and nurtured by Detroit. You also neglected to point out that the Japanese government froze Detroit out of the Japanese market, a condition which still basically exists. And you didn't mention the competitive success enjoyed by the big three in foreign markets other than Japan, where they have competed on an equal footing with Toyota and Honda. You also seem to think that Detroit is responsible for the dominance of gas guzzlers in the domestic market over these last many years. Excuse me? How did Detroit create that overwhelming demand by the nation's hockey moms? And as far as innovation is concerned, the big three pioneered captive finance, which enabled the broad market to purchase expensive automobiles – a minor something you also neglected to point out.

Yes, the big three succumbed to the socialist economic dictum that capitalism will never innovate or change unless forced to do so by obsolescence, and like Ma Bell, they sat on many innovations rather than incur the expense of bringing them to market. That's what the Commies said we would do. But we did better – we propped up the foreign automakers with right to work laws that truly beggared Detroit with its evolutionary enhancement of worker life. That never happened in Russia, as we well know. So I suggest that the old wives maxim that you can't teach an old dog new tricks be placed in abeyance while we allow GM Ford and Chrysler to regroup with a new generation of workers and managers, and preserve the best of the past by not throwing it out with the you know what. It's never too late to mend, eh?

And by the way, how many vehicles do you own and what do you drive? Do you load the kids up in a smart car?